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Socially Responsible Investment 101 Print E-mail
24/07/2005

Jérôme Tagger, Head of Research at the European Social Investment Forum (Eurosif), answers this week's 101 on socially responsible investment (SRI)

1-What defines a socially responsible investment? Is it fundamentally different from a traditional investment in an equity or fixed income fund?

Socially Responsible Investment (SRI) combines investors' financial objectives with their concerns about Environmental, Ethical, Social and Governance (ESG) issues. The reasons why investors decide to invest 'responsibly' may vary from one investor to the next. Where the emphasis is placed on ethics or sustainable development issues, one's approach may be described as value-based, whereas when the primary focus is set on financial return, the usual terminology is shareholder value-based. In most cases, investors find their motivation is a mix of both.

Contrary to popular belief, socially responsible investors are not ready to relinquish returns. For many, taking into account ESG issues is an essential part of their risk management process. In that sense, SRI is only different from traditional investment in that it takes a broader view on the scope of investment and its impact on the behaviour of companies invested in.

The available investment vehicles (funds or mandates, index or active, equity or fixed income, etc.) are the same for both SRI and traditional investments.

2-What are the most common approaches to SRI, i.e. how can it be performed?

Investors may either include ESG criteria as a part of their investment selection process, or use their rights has shareholders to influence company behaviour with regards to ESG issues.

Common approaches include:
  • Negative screening: this consists of barring investment in certain companies, sectors or countries based on ESG criteria. This is common practice among retail funds.
  • Positive screening: the preselection, within a given investment universe, of company stocks that perform best against a defined set of sustainability or ESG criteria. This performance is measured by dedicated ratings. Its most common form is called best-in-class: it aims at maintaining sector balance within a given index. Best-in-class is very popular in continental Europe.
  • Integration: the inclusion of ESG associated risk as part of traditional financial analysis. This is a growing practice amongst fund management houses.
  • Engagement: influencing corporate policy by virtue of the position as an investor and the associated rights. Engagement does not seek to influence the stock selection process. Rather, it allows the investor to dialogue with the investee company in order to tackle selected ESG issues. Engagement is popular among UK institutional investors and has existed traditionally around issues of Corporate Governance. It is now also common for institutional investors to collaborate on their engagement activities in order to have more clout and save costs.
  • Voting: using the opportunity given at annual general meetings to cast votes on the proposed resolutions.

Additionally, it is important to note that these approaches are not mutually exclusive, but rather complementary as they seek to address ESG issues at different moments in the life cycle of an investment.

3-From an institutional viewpoint, what are the main reasons for investing in a SRI fund or mandate?

While institutional investors are generally constrained by fiduciary duty, growing regulations across Europe, particularly for pension funds, encourage them to look at ESG issues. Indeed, their dimension as long-term risks or value drivers is increasingly being recognised by the investment community. This suggests that fiduciary duty could actually require investors to become "responsible" investors.

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